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Breakthrough Thoughts


									comment breakthrough thoughts

                                Breakthrough Thoughts
                                                        Managing the Maze of
                                                        Multisided Markets
                                                        Running a platform business? Take a tip from
                                                        Hiromoto Fukuda’s dating club.

                                                        by David S. Evans


                                                                    iromoto Fukuda started       Mr. McNamara loaded the charges

                                                                                                                                          Illustration by Lars Leetaru
                                                                    a new kind of dating         on the merchants. American
                                                                    club in Osaka a few          Express Company adopted this
                                                                    years ago. At the Tu-Ba      pricing model a few years later, and
                                                                    Café, men and women          made a fortune.
                                                                    sit on opposite sides of a         New York City mayor and
                                                                    glass divide. A man who      business information entrepreneur
                                                                    sees a woman he wishes       Michael Bloomberg didn’t call the
                                                        to meet can ask a waiter to carry a      Bloomberg Professional Service a
                                                        “love note” to her. Mr. Fukuda           club when it was launched in 1982,
                                                        knew he needed to get his pricing        but the global data and news power-
                                                        right to ensure there would be           house that this club became rests on
                                                        enough men for the women, and            insights parallel to those of Hiromo-
                                                        women for the men. So the Tu-Ba          to Fukuda and Frank McNamara.
                                                        Café charges men $100 for mem-           Like other information services,
                                                        bership plus $20 a visit — and lets      Bloomberg L.P. provides proprietary
                                                        women in free.                           financial data via an electronic
                                                             Frank McNamara started a dif-       network. Unlike others, however,
                                                        ferent kind of club in 1950: He          Bloomberg recognized early on that
                                                        invented the credit card. A “mem-        the system would be most valuable
                                                        ber” of the Diners Club could            if it linked customers to a vast array
                                                        charge meals at restaurants and pay      of third parties offering services
                                                        the card company at the end of the       ranging from securities trading to
                                                        month. Like Hiromoto Fukuda,             electronic “road shows.” Users pay a
                                                        Mr. McNamara recognized that it          monthly fee ($1,300 per terminal
                                                        takes two to tango. Without enough       for multiple terminals). But to
                                                        cardholders, merchants wouldn’t          attract the ocean of content that
                                                        participate, and without enough          makes the service so popular
                                                                                                                                               strategy + business issue 32

                                                        merchants on board, customers            with financial-services professionals,
                                                        wouldn’t bother to obtain a card.        Bloomberg often doesn’t charge
                                                        Merchants were equivalent to the         independent content providers
                                                        men in the dating club, and the          much for access to the platform.
                                                        cardholders were like the women, so            Multisided markets (markets
                                                                                                                                           comment breakthrough thoughts
that link two or more distinct but                   tives for gathering information, but     David S. Evans (
interdependent groups of cus-                        Bloomberg offers one-stop shop-          is a senior vice president at National
                                                                                              Economic Research Associates in
tomers) have been around for                         ping for almost every conceivable        Cambridge, Mass., where he focuses on
decades, but they’re proliferating                   source of financial data.                regulatory policy and business strategy in
                                                                                              industries challenged by rapid changes in
rapidly today as modern informa-                          The fact that circumstances         technology and market organization.
tion technology creates more oppor-                  make it possible for a platform to       Mr. Evans is a coauthor of Did Microsoft
tunities for organizing complex                      exist does not mean that it will.        Harm Consumers? Two Opposing Views
                                                                                              (American Enterprise Institute, 2000). He
markets. (See Exhibit 1.) Although                   Moreover, even if a platform is built,   has worked as a consultant for the
the “platforms” that businesses                      potential customers may find other       Microsoft Corporation.
create to serve multisided markets                   ways to obtain the services. IBM
differ widely in technology and                      maintained an operating system for
organizing institutions, all share                   its mainframe computers, but
three features:                                      expended less effort to make it a
     • Each platform serves two or                   ubiquitous platform than the                                                                 2
more distinct groups of customers.                   Microsoft Corporation did with
Examples: men and women, mer-                        Windows. And although you can
chants and cardholders, financial-                   find your true love on Yahoo Per-
services users and financial-services                sonals, you still might prefer chat-
sellers.                                             ting up strangers on a Sunday walk
     • The value of the platform to                  in the Boston Public Garden.
each group of customers increases                         The economics underlying
along with the number of customers                   these multisided platforms are only
in the other interdependent groups.                  just now being plumbed, with a
Credit card holders want every store                 couple of French academics, Jean-
near them to accept their plastic; the               Charles Rochet and Jean Tirole, in
more customers carrying the card,                    the forefront. We already know
the more stores value it.                            enough, however, to recognize that
     • The platform must provide a                   you’ll poke yourself in the eye if you
superior way for the customer                        apply the rules of thumb about tra-
groups to interact. Financial-services               ditional markets learned by every
professionals have plenty of alterna-                MBA candidate in the land. As the

Exhibit 1: A Sampling of Multisided Markets

                              Customers                           Who Pays

 Network Television           viewers, advertisers               advertisers

 Payment Cards                cardholders, merchants             in large part, merchants

 Yellow Pages                 phone shoppers, merchants          merchants

                              hardware makers, software
 Computer Operating Systems   applications developers,           computer users
                              computer users

 Video Game Consoles          players, game makers               both sides

 Web Auctions                 buyers, sellers                    sellers
comment breakthrough thoughts

                                dating club example plainly shows,         ramping up slowly. So it built both        you hope to scale up by offering
                                equating incremental costs to incre-       sides of the platform by piecing           third-generation (3G) broadband
                                mental revenues for each class of          together some small existing card          content to subscribers. Should you
                                consumers doesn’t work. Nor, for           programs, such as one operated by          price low to lure phone subscribers
                                that matter, will pricing low to build     Gourmet magazine. American                 and rely more on the revenue from
                                market share and lock in customers         Express subsequently followed a            charging the content providers for
                                — a lesson learned the hard way by         “marquee” strategy for getting both        access to your millions of cus-
                                dozens of dot-coms operating in            sides engaged, that is, sign up highly     tomers? Should you charge the sub-
                                multisided markets.                        valued customers on each side to           scribers and give the content
                                                                           attract more on the other. From the        providers an easy ride? Or should
                                Both Sides on Board                        merchant’s perspective, marquee            you do something in between?
                                Frank McNamara faced the classic           customers included free-spending                 Traditional market research,
                                chicken-and-egg problem that keeps         business travelers not inclined to         which predicts prospective cus-
       3                        every platform wannabe up at night.        comparison shop. From the card-            tomers’ reaction to varying price
                                Diners Club needed cardholders to          holder’s perspective, it meant high-       points, won’t help much because
                                get merchants to sign up. Mean-            end stores whose presence in the           demand by multiple groups of plat-
                                while, consumers were reluctant to         network conferred status on the big        form customers is interdependent.
                                carry the card unless a lot of mer-        spender.                                   You thus have to figure out how
                                chants accepted it. Mr. McNamara                Malls, which are the sort of          much each side values the other,
                                and his partners started small, giv-       platforms that make it cheaper and         then calculate the prices that will
                                ing the card away to a few hundred         easier to bring together stores and        make sure that both sides show up
                                residents of Manhattan (hoping             shoppers, often follow a marquee           in the right numbers — and, of
                                they were hungry). Sometimes cards         strategy, too. They lure “anchors,”        course, make sure the revenues will
                                were simply stuck under apartment          for example, a department store            still be adequate to generate a profit.
                                doors. Then they went from restau-         with cachet such as Saks Fifth                   Although pricing is important,
                                rant to restaurant, asking for 7 per-      Avenue or Nordstrom, to attract            it is only one element in the design
                                cent of the check if people paid with      other stores, as well as a critical mass   and implementation of a platform
                                the card. Initially, just 14 eateries      of shoppers.                               strategy. Apple Computer Inc., for
                                signed up.                                      Attracting complementary par-         example, lost its commanding lead
                                     But mighty oaks from little           ticipants to a multisided market and       in user-friendly computer operating
                                acorns do sometimes grow: By its           keeping them there requires the            systems because it picked the wrong
                                first anniversary in 1951, Diners          right pricing structure as well as the     platform model. The company sold
                                Club had about 300 merchants and           right price levels. Pity the managers      its computers and its operating
                                40,000 cardholders in the fold. Lit-       of the B2B e-commerce pioneers             system as a package, making the
                                tle more than a decade later, Diners       who thought all they had to do was         platform available to software devel-
                                Club could boast 1.5 million card-         turn on the switch and watch their         opers and computer users. Bill
                                holders and 150,000 establishments         Web sites hum with transactions.           Gates was one of those developers.
                                accepting their plastic. Mr. McNa-         Or the mobile phone network oper-          Indeed, Microsoft was the largest
                                mara may not have become the Bill          ators, who invested tens of billions       supplier of applications software for
                                Gates of credit cards, but he accom-       of dollars in spectrum for enhanced        Apple computers in the mid-1980s.
                                plished something that would have          services such as streaming video           Long before the company focused
                                made investors in many a high-tech         without making sure that they              its attention on building the Win-
                                startup envious: Diners Club was           could provide the right price incen-       dows platform, Mr. Gates realized
                                profitable from its first year. Starting   tives to get both content providers        that he could sell more Apple appli-
                                                                                                                                                                strategy + business issue 32

                                small in platform markets and scal-        and subscribers on board.                  cations if Apple sold more operating
                                ing up sometimes has advantages.                To see how complex and un-            systems. Hence, he wrote Steve Jobs
                                     When American Express decid-          intuitive optimal pricing in a plat-       a now-famous letter, in effect advis-
                                ed to break into the business in           form business can be, imagine creat-       ing him to move from a two-sided
                                1958, it didn’t have the luxury of         ing a mobile phone platform that           to a three-sided platform model by
                                                                                                                          comment breakthrough thoughts
licensing the operating system to       than time spent on the network.          quickly. Network effects, in which
independent vendors eager to make            The success of multisided plat-     the value of the services for individ-
Macintosh clones.                       form businesses ranging from             ual users rises with the total number
     The founders of Palm Inc. were     American Express to Palm to NTT          of users, would then theoretically
quicker to recognize the virtues of a   DoCoMo has led some traditional          serve as a potent barrier to entry for
multisided platform. They started       one-sided businesses to restructure      competitors.
with an integrated product, a hand-     as platforms. Take voice mail. Sever-          The idea looked good in the
held device with a terrific small       al firms developed software that         business plans that made the rounds
operating system and a killer hand-     telecoms use to operate voice-mail       of the venture capitalists. But it has
writing recognition application. But    systems in which the only customers      hardly ever fit the realities of plat-
they responded to the evolving busi-    are subscribers. Unisys, one of the      form industries. Diners Club was
ness environment by turning this        largest messaging vendors, with 110      first in payment cards, and it devel-
traditional one-sided business into a   million voice-mail boxes worldwide,      oped a huge network. Yet that didn’t
two-sided platform business by          is extending this old technology to a    stop American Express from top-                 4
encouraging independent software        four-sided platform. The company         pling it. The first general Web auc-
developers to write applications for    is developing platforms that connect     tion site wasn’t eBay Inc. — it’s just
                                                                                 the only one anyone remembers.
                                                                                 Nor, for that matter, did Palm sell
Although pricing is important,                                                   the first PDA.
it is only one element in the                                                          Experimenting on a small scale
                                                                                 and then expanding can help plat-
design and implementation of                                                     form businesses avoid catastrophic
                                                                                 losses. The mighty eBay started as
a platform strategy.                                                             an auction site for people who want-
                                                                                 ed to buy and sell Pez candy dis-
the Palm. The company trans-            content providers, subscribers, appli-   pensers. It got the pricing model
formed this two-sided platform into     cation developers, and telecom-          right (sellers pay, buyers don’t) and
a three-sided platform in 1997,         munications distributors.                worked the kinks out of the plat-
when it started licensing the Palm                                               form design before rushing to fill
OS to other makers of handhelds.        Experiment and Evolve                    the market. Over time it has
Today 13 companies (plus Palm)          There’s no substitute for experience     expanded to other C2C products, to
sell “Palm-powered” devices.            in solving the chicken-and-egg           B2C, and ultimately to B2B. Yet
      NTT DoCoMo Inc., the giant        problem, or in setting prices to bal-    where scale mattered, eBay man-
Japanese mobile phone service           ance demand. So late entrants can        aged to get there quickly. For exam-
provider spun off from NTT, runs a      often learn a lot from pioneers.         ple, it used its brand recognition
successful three-sided platform. Its    Moreover, just because a variant of a    and national market reach to
phones enable users to access a vari-   platform strategy has worked well        become a powerhouse in used-car
ety of nonvoice services, ranging       doesn’t imply that some clever fol-      sales in a matter of months.
from interactive Sony PlayStation       lower can’t do it better. American             Arguably the biggest mistakes
games to purchases from vending         Express didn’t start making money        in scaling multisided platforms have
machines. Content providers get         until it experimented with higher        been made by the mobile phone
access to the network free of charge,   cardholder fees and lower merchant       industry. The industry collectively
paying NTT DoCoMo only a per-           fees than its competitors were charg-    spent $115 billion on technology
centage of the fees charged to users    ing.                                     and spectrum to facilitate 3G high-
of their premium services. The com-          Or consider the role of first-      speed service for cell phones. How-
pany generates most of its revenues     mover advantages. During the dot-        ever, it failed to understand that the
from subscriber fees, which are         com boom, everyone seemed to             content to make customers willing
billed according to the amount of       agree on this formula for success:       to pay premiums for 3G service
information downloaded rather           Price low to build market share          wasn’t yet available.
comment breakthrough thoughts

                                      Not every mobile phone com-         advertising. Cable television, by        entry may yield first-mover advan-
                                pany has been badly damaged by            contrast, made most of its money         tages, or merely simplify the search
                                failing to get the 3G platform right      from access charges, giving it the       for successful strategies by those that
                                the first time around. NTT DoCo-          option to offer viewers less advertis-   follow. Consider, too, that customer
                                Mo, which succeeded so dramatical-        ing as well as premium content.          group interdependence makes it far
                                ly in selling the relatively limited      AOL Time Warner Inc., which              more difficult to anticipate the
                                services available through the previ-     delivers relatively rich content along   impact of changes in the business
                                ous generation of mobile phone net-       with Internet access, is now facing a    environment.
                                works, has finessed the 3G content        similar problem in competing                  Still, along with greater chal-
                                problem by expanding very cau-            with plain-vanilla Internet service      lenges go greater rewards to the
                                tiously into the new technology.          providers.                               nimble and the better capitalized.
                                By contrast, U.K.-based Vodafone               Note, too, that price competi-      Many of the great business empires
                                Group PLC, the largest mobile             tion between platforms can be fierce     of the modern era — think eBay,
       5                        communications supplier in the            when customers on one side have          American Express, Microsoft, Cisco
                                world, spent $20 billion for the
                                spectrum needed for 3G services
                                in the U.K. alone. Among other            Multisided platforms, especially
                                issues cited, Vodafone’s deal with
                                Vivendi Universal SA to provide
                                                                          those in new markets, too often
                                content apparently discouraged par-       require clean-sheet planning
                                ticipation by competing content
                                providers.                                from strategists.
                                      Business strategies would be rel-
                                atively simple to design if platform      practical alternatives for obtaining     — have prospered precisely because
                                businesses just had to worry about        services. The Milwaukee Journal          they have excelled at making multi-
                                frontal assaults — the shopping           Sentinel dominates the newspaper         sided platforms work to their advan-
                                mall across the street, the Microsoft     market in the city. That doesn’t         tage. Today dating clubs, tomorrow
                                Xbox challenge to the Sony Play-          mean it can exercise much pricing        the world. +
                                Station, Yellow Pages USA going           power, though: Advertisers in Mil-                               Reprint No. 03301
                                head-to-head with the telecom             waukee have many other ways to
                                company SBC Communications                gain the attention of potential cus-
                                Inc. in some U.S. regional markets.       tomers.
                                In these cases, at least, firms are
                                fighting on the same battlefield.         Tomorrow the World
                                      But sometimes platforms inter-      Markets hardly ever cooperate by
                                sect in complex ways. One platform        following simple rules derived from
                                may connect customer groups A             economic theory. In traditional
                                and B, while another links customer       markets, however, economic tru-
                                groups B and C. So the managers of        isms can at least serve as bench-
                                the respective platforms must set         marks and starting points for more
                                prices and services with an eye on        nuanced analysis. By contrast, multi-
                                how the other platform treats cus-        sided platforms, especially those in
                                tomer B.                                  new markets, too often require
                                      Free over-the-air television        clean-sheet planning from strate-
                                                                                                                                                               strategy + business issue 32

                                faced this problem with cable televi-     gists. With multiple, yet interde-
                                sion. Free TV had succeeded by            pendent, customer groups to serve,
                                delivering relatively inexpensive-to-     companies find that direct costs
                                produce content to viewers and pay-       provide little guidance for pricing
                                ing the bills with revenues from          strategies. By the same token, early

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